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FX Options Introduction

FX Options Introduction

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FX Options Introduction

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  1. y e s f x . c o m . c y FX Options Introduction

  2. y e s f x . c o m . c y Agenda • Options • Exotic options • The Greeks • Options trading • Margins • Research and Analysis

  3. y e s f x . c o m . c y FX derivatives explained • Options FX options - A contract that grants the holder the right, but not the obligation, to buy or sell currency at a specified exchange rate during a specified period of time. For this right, a premium is paid to the broker, which will vary depending on a series of variables that will be covered in future slides. Currency options are one of the best ways for corporations or individuals to hedge against adverse movements in exchange rates.

  4. y e s f x . c o m . c y The Call • The right to BUY the underlying instrument at a certain price on a specified future date • Why? You want to capitalize on an increasing trend in the spot market. The trend could be either long-term or short-term

  5. y e s f x . c o m . c y The Call • Example: You believe EURUSD will rise towards the 1.5000 level in about a month’s time. The spot rate is currently 1.4537. You buy a EURUSD Call with a one month expiry and a strike of 1.4500. The price/premium is 152 pips. • Upside: Unlimited, and calculated by: • Closing spot price – Strike price - premium = profit • Example: 1.5000 - 1.4500 - 152 = 348 pips • Downside: The premium (152 pips) which will be lost if the option is Out-of-The-Money (OTM) at expiry (as opposed to In-The-Money(ITM), or At-The-Money (ATM))

  6. y e s f x . c o m . c y The Put • The right to SELL the underlying instrument at a certain price on a specified future date • Why? You want to capitalize on a decreasing trend in the spot market. The trend could be either long-term or short-term

  7. y e s f x . c o m . c y The Put • Example: You believe EURUSD will fall towards the 1.4000 level in about a month’s time. The spot rate is currently 1.4545. You buy a EURUSD Put with a one month expiry and a strike of 1.4500. The price/premium is 149 pips. • Upside: Unlimited, and calculated by: • Strike price – closing spot price - premium = profit • Ex. 1.4500 - 1.4000 - 149 = 351 pips • Downside: The premium (149 pips) which will be lost if the option is not ITM at expiry.

  8. y e s f x . c o m . c y FX options continued… • Exotic options A type of option that differs from common American or European options in terms of the underlying asset or the calculation of how or when the investor receives a certain payoff. These options are more complex than options that trade on an exchange, and generally trade over the counter.

  9. y e s f x . c o m . c y It’s all Greek to me! • Δ (Delta) represents the rate of change between the option's price and the underlying asset's price - in other words, price sensitivity. • Γ (Gamma) represents the rate of change between an option portfolio's delta and the underlying asset's price - in other words, second-order time price sensitivity. • Θ (Theta) represents the rate of change between an option portfolio and time, or time sensitivity. • ϒ (Vega) represents the rate of change between an option portfolio's value and the underlying asset's volatility - in other words, sensitivity to volatility. • ρ (Rho) represents the rate of change between an option portfolio's value and the interest rate, or sensitivity to the interest rate. • Factors affecting the price of an option: • Changes in the price of the underlying security • Strike price • Time until expiration • Volatility of the underlying security • Interest rates

  10. y e s f x . c o m . c y Greeks continued…

  11. y e s f x . c o m . c y Options Trading via SaxoTrader • Low option margin requirements • Depends on the volatility (Vega) and spot price movement (Delta) of the underlying asset • Takes hedging-effect of other spot and option positions into account (if the options have expiry on the same date!) • Can use investments in other products as collateral! • Assistance with setting up option strategies • Clients can chat directly with dealers through SaxoTrader

  12. y e s f x . c o m . c y Margins • As with all margin-traded assets, FX has its own, inherent margin requirements relative to the currencies you are trading, however options have further considerations when calculating your margin requirement • Delta: • Delta margin = Spot exposure * FX spot margin requirement • Vega: • Vega margin = Vega * Vol of spot * Vol Factor * Notional amount Vega calculation

  13. y e s f x . c o m . c y Margins continued… • Example Delta: • If you purchase a 25 Delta EUR/USD option for 1,000,000, you will have an exposure in the spot of EUR 250,000. If you have a spot margin requirement of 2%, your Delta margin will amount to 2%*250,000 EUR = EUR 5,000 as shown in the table below. • Example 1 Vega: • A client sells a EUR/USD Call for 1 week with a notional amount of 1 million. Furthermore, assume that the Vega is 0.055 and the underlying asset has a volatility of 10%. Since the client is a seller of the option, the worst-case scenario for the client is when the volatility increases. Hence, the Vol Factor is found in the "Change up - 1 Week" expiry bucket which lists it as 100%. The Vega margin of the option is then calculated as 0.055 * 10% * 100% *1,000,000 EUR = 5500 EUR. • Example 2 Vega: • A client buys a 1 month EUR/USD Put for one million EUR with a Vega of 0.12 and a volatility of 10%. In this case, the worst-case scenario is when the volatility decreases. Therefore, the Vol Factor is to be found in the "Change down - 1 Month" expiry bucket where it is listed as 20%. Using the same equation as above we get Vega margin = 0.12 * 10% * 20% * 1,000,000 EUR = 2400 EUR.

  14. y e s f x . c o m . c y Research and Analysis Saxo Trader II is packed with research and analysis tools • Our in house strategy team provide coverage of all the markets including trading ideas • Our ‘dealer chat’ allows you to access real live traders 24/5 • External analysis from some of the best names in the business • A technical analysis tool, as well as the study types that exist within Saxo’s comprehensive charts (over 60 different studies to choose from) give you the edge you need

  15. y e s f x . c o m . c y Research and Analysis continued… News: Our live, streaming news gives you up-to-date information from four of worlds leading providers, including AFX, Dow Jones, MNI and UBS.

  16. y e s f x . c o m . c y FX options – Basic Directional Strategies

  17. y e s f x . c o m . c y Agenda • Intro • Pay-out profile & the four base positions • Basic directional strategies 1) Covered Call 2) Covered Put 3) Bull Call Spread 4) Bear Put Spread • Conclusions

  18. y e s f x . c o m . c y Agenda • Intro • Pay-out profile & the four base positions • Basic directional strategies 1) Covered Call 2) Covered Put 3) Bull Call Spread 4) Bear Put Spread • Conclusions

  19. y e s f x . c o m . c y The at expiry pay-out profile: Price of the underlying at expiry (in this example EURUSD) Profit Loss 1,45 1,46 1,47 1,48 1,49 1,50 1,51 1,52 1,53 Profit or loss of the strategy at expiry of the option(s)

  20. y e s f x . c o m . c y 4 basic positions – “the building blocks” Long call (bought) Long put (bought) Profit Profit Profit Profit Loss Loss Loss Loss Short call (sold) Short put (sold)

  21. y e s f x . c o m . c y Long Spot Position Short Spot Position Profit Profit Profit Loss Loss Loss Combined position

  22. y e s f x . c o m . c y Agenda • Intro • Pay-out profile & the four base positions • Basic directional strategies 1) Covered Call 2) Covered Put 3) Bull Call Spread 4) Bear Put Spread • Conclusions

  23. y e s f x . c o m . c y Agenda • Intro • Pay-out profile & the four base positions • Basic directional strategies 1) Covered Call 2) Covered Put 3) Bull Call Spread 4) Bear Put Spread • Conclusions

  24. y e s f x . c o m . c y 1. Covered Call • Scenario: EURUSD is trading at 1,4200 and you believe in a further increase over the next 2 weeks, but you don’t think 1,4500 will be reached • Actions: • You go long 1.000.000 in EURUSD from 1,4200 in the spot-market • You sell an out-of-the-money Call Option on EURUSD, with strike at 1,4500 that expires in two weeks (notional value 1.000.000 EUR) • You receive 95 pips (0,0095), corresponding to 9500 USD for the sale of the option

  25. y e s f x . c o m . c y 1. Covered Call – pay-out profile: Spot-position: Long EURUSD from 1,4200 Sell a EURUSD call with strike 1,4500 New position: a ”synthetic” short put Lower risk Profit Loss 1,4500

  26. y e s f x . c o m . c y 1. Covered Call – potential profits: From spot position: 1.4500 -1.4200 = 300 pips From option (the received premium) = 95 pips Maximum potential profit = 395 pips On a 1.000.000 EURUSD position = 39.500 USD

  27. y e s f x . c o m . c y 1. Covered Call – conclusions: • Advantages of the strategy: • The 95 pips premium received from the sale of the option boosts the profitability of the strategy, if you get the direction right • The premium you received can mitigate losses if EURUSD falls • Downsides to the strategy: • You renounce the profits that you could have derived from a stronger-than-expected rally in the market • You have full risk to the downside on the spot position – the received • premium can only mitigate this, not hedge it completely

  28. y e s f x . c o m . c y Agenda • Intro • Pay-out profile & the four base positions • Basic directional strategies 1) Covered Call 2) Covered Put 3) Bull Call Spread 4) Bear Put Spread • Conclusions

  29. y e s f x . c o m . c y 2. Covered Put • Scenario: EURJPY is trading around 161.00 and you think the market will fall further over the next 3 weeks - but you do not think 155,00 will be reached • Actions: • You go short 1.000.000 EURJPY • You sell an out-of-the-money EURJPY put option for 1.000.000 EUR at a level that you think the market won’t reach: 155.00. The option expires in 3 weeks • You receive 72 pips, corresponding to 720.000 JPY for the sale

  30. y e s f x . c o m . c y 2. Covered Put – pay-out profile: Spot-position: short EURJPY from 161.00 Sell EURJPY put with strike 155.00 Higher profits than naked put – down to a bit below 155 Profit Loss 158 161 New position: short ”synthetic” put

  31. y e s f x . c o m . c y 2. Covered Put – potential profits: From spot position: 161.00 – 155.00 = 600 pips From option (the received premium) = 72 pips Maximum potential profit = 672 pips On a 1.000.000 EURJPY position = 6.720.000 JPY

  32. y e s f x . c o m . c y 2. Covered Put – conclusions: • Advantages of the strategy: • The 72 pips premium received from the sale of the OTM option • The fact that you sold the option without running unlimited risk on the option itself, because you also have the short spot-position • Disadvantages of the strategy: • You forego profits that you would have made in a market that • falls further than expected • You have full risk to the upside – if market goes up, you lose all the way unless you close your spot position

  33. y e s f x . c o m . c y Agenda • Intro • Pay-out profile & the four base positions • Basic directional strategies 1) Covered Call 2) Covered Put 3) Bull Call Spread 4) Bear Put Spread • Conclusions

  34. y e s f x . c o m . c y 3. Bull Call Spread • Scenario: GBPUSD is trading around 1,8750 and your view is bullish in the midterm. You acknowledge that the market might go against you temporarily, and wish to have limited downside risk • Actions: • You buy a call option struck at 1,8750 that expires in 1 month for 1.000.000 GBPUSD. You pay 267 pips for this option • You also sell another call option – with a higher strike, that you think • the market won’t reach, in this case 1,9200 (same expiry, same notional amount). You receive 94 pips for this option • You total cost to set up the strategy: 267 – 94 = 173 pips

  35. y e s f x . c o m . c y 3. Bull Call Spread – pay-out profile: Bought call on GBPUSD, strike 1,8750 Sold call on GBPUSD, strike 1,9200 New position: Bull Call Spread Lower risk/cost 1,8750 Profit Loss 1,9200 Break even point of the strategy Break even of the bought call

  36. y e s f x . c o m . c y 3. Bull Call Spread – potential profits: 1) Cost to set up portfolio: premium paid for bought call: 267 pips premium received for sold call: 94 pips total: 267 – 94 = 173 pips 2) Max. potential income: 1,9200-1,8750 = 450 pips 3) Max. profit: (income – cost) 450 – 173 = 277 pips (on 1.000.000 GBPUSD = 27.700 USD)

  37. y e s f x . c o m . c y 3. Bull Call Spread – conclusions: • Advantages of the strategy: • Lower cost than naked call because of the sold OTM call option • You can stay in the market if it goes against you temporarily • Downside to strategy: • There is a premium-cost to set up the strategy • You might miss out on profits that you could have earned • on a stronger-than-expected rally in the market

  38. y e s f x . c o m . c y Agenda • Intro • Pay-out profile & the four base positions • Basic directional strategies 1) Covered Call 2) Covered Put 3) Bull Call Spread 4) Bear Put Spread • Conclusions

  39. y e s f x . c o m . c y 4. Bear Put Spread • Scenario: you have a bearish view on USDCHF on a 1 week horizon • Currently, USDCHF is trading at 1,0894 and you wish to enter a short position • You acknowledge that the market might go against you temporarily, • and wish to have limited risk to the upside • Actions: • You buy a put, with strike 1,0890 (approximately at the money) • for 1.000.000 USD. You pay 118 pips for this option • You sell a put option with strike 1,0750, a level that you think the • market won’t reach. You receive 54 pips for this option

  40. y e s f x . c o m . c y 4. Bear Put Spread – pay-out profile: Bought USDCHF put with strike 1,0890 (ATM) Sold USDCHF put with strike 1,0750 (OTM) New position: Bear Put Spread Lower cost/ risk 1,0890 Profit Loss 1,0750 Break even point of the bought put. Break even point of the strategy

  41. y e s f x . c o m . c y 4. Bear Put Spread – potential profits: 1) Cost to set up portfolio: premium paid for bought put: 118 pips premium received for sold call: 54 pips total: 118 – 54 = 64 pips 2) Max. potential income: 1.0890-1.0750 = 140 pips 3) Max. profit: (income – cost) 140 – 64 = 76 pips (on 1.000.000 USDCFD = 7.600 CHF)

  42. y e s f x . c o m . c y 4. Bear Put Spread - Conclusions • Advantages of the strategy: • Lower cost than naked put because of the sold OTM put • You can stay in the market if it goes against you • Downsides to the strategy: • There is a premium-cost to set up the strategy • You risk missing out on profits that you could have made • on a stronger-than-expected slump in the market

  43. y e s f x . c o m . c y Agenda • Intro • Pay-out profile & the four base positions • Basic directional strategies 1) Covered Call 2) Covered Put 3) Bull Call Spread 4) Bear Put Spread • Conclusions

  44. y e s f x . c o m . c y FX options – Plain Vanilla Strategies

  45. y e s f x . c o m . c y Agenda • The concept of volatility • Historical volatility & implied volatility • Impact on option pricing • Plain vanilla volatility strategies: • Straddle • Strangle

  46. y e s f x . c o m . c y The concept of volatility Price pattern B: Price pattern A:

  47. y e s f x . c o m . c y Agenda • The concept of volatility • Historical volatility & implied volatility • Impact on option pricing • Plain vanilla volatility strategies: • Straddle • Strangle

  48. y e s f x . c o m . c y Historical volatility & implied volatility Historical volatility: is an accurate description of past volatility

  49. y e s f x . c o m . c y Historical volatility & implied volatility Historical volatility: is an accurate description of past volatility Implied Volatility: is the markets view on how volatile an asset will be in the future

  50. y e s f x . c o m . c y How is volatility expressed? Red line= implied volatility, EURUSD Blue line = historical volatility EURUSD